Second Quarter Conference Call, Fiscal Year 2020



Before we begin, we call your attention to the fact that we may make forward-looking statements during the course of this conference call. These forward-looking statements are not guarantees of our future performance and are subject to risks, uncertainties and other factors that could cause actual performance to differ materially from such statements. A description of these risks, uncertainties and other factors is contained in our news release of April 24, 2020 our most recent Form 8K filed on April 24, 2020 and in certain of our other public filings with the SEC.


We've provided some financial schedules to help our listeners better follow along with the prepared comments. For those of you who do not already have the document, a copy of today's financial presentation is available on our investor relations webcast page at


Good morning. Thanks for joining us. This morning we’ll report on the second quarter of fiscal ‘20 and discuss the future outlook for the company in light of the COVID-19 crisis. Given the uncertainty in global markets, we’re suspending our normal practice of providing detailed guidance for the remainder of the fiscal year.

In reviewing my comments from 90 days ago, COVID-19 was not a topic on our agenda – indeed, it wasn’t even a word in our vocabulary. In late January, we talked about Brexit, the U.S. trade dispute with China and unrest in the Middle East. Some 8 weeks later, all our attention shifted to responding to the rapidly changing situation as a result of the spread of the virus.  

I hope our comments today will leave our investors with 2 clear messages about our business.

1) Short term strength from our diversity.


2) Long-term value from our fundamentals

As usual, I’ll start with the headlines.



1) First, the second quarter was strong. The pandemic only started to affect our operations late in the quarter and had relatively little impact on our results.  Sales in the quarter were up 6%, net earnings were up 21% and earnings per share were up 26% from a year ago. Free cash flow was $12 million and during the quarter we purchased 1.6 million shares under our share buyback program. The first half of fiscal ’20 is a record for the company in terms of sales, net earnings and earnings per share and provides a solid foundation as we enter this crisis.  

2) Second, early in March we started to understand the scope of the emerging pandemic. We set 2 clear priorities. First and foremost was the health and safety of our employees and their families. And second, to continue to meet the needs of our customers and thereby secure the financial well-being of the company.  

3) Third, we took action. We transitioned to working from home wherever possible and implemented changes in our work practices for production employees who continued to come into the plants. We focused our financial attention on modeling liquidity and leverage. We implemented expense and cash conservation actions including hiring and salary freezes, elimination of consulting and other discretionary expenses and focused on minimizing capital expenditures. We paused our share repurchase program and alsodecided to temporarily suspend our quarterly dividend payment.  

4) Fourth, we assessed our markets and developed future business scenarios.  We believe we are relatively well positioned to weather this storm. Our diversity across markets is our strength. Our Defense and Space businesses combined make up almost half our sales and are mostly U.S. government funded. Both businesses are strong and should continue to be well supported. Our medical business is close to 10% of our sales and we’re seeing increasing demand for our pumps. Our industrial business is just over a fifth of our sales. We anticipate we’ll see a drop off in demand in these markets as the crisis unfolds. Finally, our commercial aircraft business is likely to be the hardest hit. However, to put this into context, commercial OEM customers represented 17% of our total sales in the first half of fiscal ‘20 and sales into the aftermarket were about 5% of our business in the same period.  

5) Fifth, our financial position is healthy and our relationship with our bank group strong. We refinanced our entire balance sheet over the last 6 months and are conservatively leveraged.

6) Sixth, we’re investing where we can to support the fight against the virus.  We’re adding staff in our medical facilities as demand for pumps surges. In addition, our industrial group supplies small motors that are used in ventilators. The demand for these motors has increased from 800 units per month to 30,000 units per month. Our staff is working tirelessly to increase our capacity and expand the supply chain to meet this need.  

In summary, I would describe our situation today as stable. The vast majority ofour staff around the world are working productively. Most of our facilities continue to produce products and both our supply chain and our customers continue to operate. Under the new practice of social distancing, we estimate we are operating at perhaps 80%-90% of our normal capacity. It may be early days yet in the crisis, but so far we’re meeting our 2 primary objectives of keeping our employees safe and maintaining the financial health of our company. This is a testimony to the commitment of our employees around the globe and I would like to thank each of them for their dedication.  


Now let me return to my normal reporting format. I’ll describe the results of the second quarter in a little more detail and then walk through each of the operating groups.


Q2 Fiscal ‘20

Sales in the quarter of $765 million were 6% higher than last year driven by organic growth across our A&D portfolio. Sales were up 17% in our Space & Defense group, up 6% in our Aircraft Group and down just 1% in our industrial group. Taking a look at the P&L, our gross margin was more or less in line with last year. R&D spending was down on lower Aircraft activity while spending on selling and admin was up on the higher sales. Interest expense was marginally higher than last year on higher debt levels. The effective tax rate this quarter was low at 19.2% as a result of some special items. The overall result was net income of $50 million, up 21% from last year, and earnings per share of $1.48, up 26% from last year. 

 Fiscal ’20 Outlook

Given the uncertainty of the present economic situation, we’re not providing specific guidance for the second half of our fiscal year. However, I will offer some qualitative comments about each of our markets. I would stress that the situation in each of our markets is very fluid and there are many unknowns, so our commentary today could change materially in the future.

Now to the segments. I’d remind our listeners that we’ve provided a 2-page supplemental data package, posted on our webcast site. We suggest you follow this in parallel with the text.



Aircraft Q2

Sales in the quarter of $341 million were 6% higher than last year, with all the growth coming on the military side of the house. Sales were up over 20% on the F-35. Sales were also higher on the Blackhawk helicopter and on the KC-46 tanker. In the military aftermarket, it was a similar story with higher F-35 and Blackhawk activity. We also enjoyed higher F-15 aftermarket sales. This quarter, the army down-selected to 2 competitors for the next phase of both the FLRAA and FARA future vertical lift programs. We are well positioned on the Textron V-280 for the FLRAA contest and are happy to report that we are on both the Bell/Textron and Sikorsky teams for the FARA competition.  

On the commercial side, total sales were flat, with higher aftermarket sales compensating for slightly lower sales to our OEM customers. OEM sales to Boeing were in line with last year. We saw nice growth on the 787 program which compensated for 737 sales down 50% from a year ago and 777 sales down 20%.  Airbus sales were off over 10% from last year, driven by lower A350 activity and A380 sales essentially going to zero. The commercial aftermarket was up mostly on 787 activity as the size of the fleet out of warranty continues to grow.  

Aircraft Margins

Margins in the quarter of 10.2% were up from 8.5% a year ago. In the second quarter last year, we booked a $10 million charge associated with a quality issue on a vendor supplied part. The higher margins this year are a combination of the higher sales and a better mix, as well as the absence of last year’s charge. However, the margin performance in the quarter was tempered by about 100bps as a result of a charge on a development program.

Our Operations 2.0 improvement activities continued through the first 2 months of the quarter but have since slowed as we focused on restructuring our working environment. Progress will continue over the coming quarters but not at the pace we were planning.  

Aircraft fiscal 20

In offering some thoughts on the coming 6 months, I will try to address both supply side and demand side issues. Let me start with the military half of the business. On the supply side, our facilities are located in the U.S. and the UK, have been deemed essential by the authorities and continue to operate. To date our supply base has continued to function well although we have a couple of suppliers who have shut their facilities for multiple weeks. We’re optimistic that they will return to work before our inventory of parts is depleted but the supply chain will remain our biggest unknown in meeting our customer needs. On the demand side, the vast majority of our business is funded by the US DOD and we’re confident that this market will remain strong. In summary, we’re optimistic that the military side of the aircraft business will remain solid for the coming quarters, with the risks skewed to the supply side of the equation.

Turning now to our commercial business, our major factories are in the Philippines, the UK and the US. All facilities continue to operate. Similar todefense we have risks in the supply chain but, for the moment, we are well positioned to meet the needs of our customers. On the demand side, it is a much more concerning picture.  Our airline customers are dramatically reducing flights, and we believe that our OEM customers will cut production rates significantly. We’re working with all our customers to get a clearer picture of their demand over the coming quarters, but the situation continues to evolve daily. In summary, we believe the commercial side of our business will be significantly lower over the coming quarters with the risk skewed to the demand side of the equation.


Space and Defense

Space and Defense Q2

Sales in the quarter of $193 million were 17% higher than last year. This quarter it is the Space market that is providing the majority of the growth, with sales up 38% over a year ago. We had significant growth in hypersonic launch vehicle activity and NASA development programs, as well as strength in our satellite engine and avionics product lines. Note that we record our hypersonic development activity partially under our Space market and partially under our Defense market. Launch vehicles used to raise hypersonic weapons into space are included under Space while fin steering controls on hypersonic vehicles used during descent are included under Defense.  

Defense sales were up 7% from last year with strength across most of the product lines including missiles, vehicles and naval systems. Our security business was down as planned shipments to customers moved out to future quarters.  

Space & Defense Margins

Margins in the quarter of 12.8% were up from last year. We’re pleased with this margin performance given the high level of funded development within the group.  This funded development is very positive for the long term as it sets the foundation for future production programs but tends to dilute margins in the short term.

Space & Defense fiscal ‘20

In Space & Defense, it is a similar story to our military aircraft business. On the supply side, most of our facilities are in the US, with a couple of operations in Europe. All sites are operational and our risks are mostly in the supply chain. On the demand side, most of our business is supported by U.S. government funding.  We believe that funding should continue, more or less as planned, for the remainder of our fiscal year. Staffing challenges and production inefficiencies as a result of social distancing measures will result in lower productivity and lower output than normal, but overall, the business should weather the next couple of quarters reasonably well.  


Industrial Systems

Industrial Systems Q2

Sales in the quarter of $231 million were down marginally from last year. The stability on the top line belies the sales shifts in our major markets. Sales into Energy applications were 23% higher due to the fact that half of the acquired sales from our recent GAT acquisition in Germany are coded to this market. GAT specializes in Fluid Rotary Units which complement our slip ring technologies. Sales were also up double digits in our Medical applications as demand for our infusion pumps continues strong. We have been gaining share in this market over several quarters as a major competitor has struggled with production challenges. As we look to the future, we anticipate continued strength in this market to support the COVID-19 crisis. Sales into Industrial Automation were down almost 10%. There were 2 factors at play. First, the continued slowdown of global capital spending, independent of the pandemic, and second, a loss of sales in the quarter, particularly in China, due to the virus. Finally, sales into our simulation and test market were also lower as demand for both auto and aero test systems, particularly in China, slowed.  

Industrial Systems Margins

Margins in the quarter were 10.7%. These margins are down from a year ago on a less favorable mix. Our traditional hydraulics products sold into industrial automation applications are off significantly from a year ago. In addition the sales from our GAT acquisition are at relatively low margin due to first year acquisition accounting effects.  

Industrial Systems fiscal 20

The outlook for our industrial business over the next couple of quarters is perhaps the most difficult to project. Here we have a combination of both supply and demand uncertainties. On the supply side, some of our facilities produce products essential in the fight against the virus, such as medical pumps and certain small motors used in ventilators. These facilities will continue to produce as fast as possible. However, most of our industrial plants, and their supporting supply chains, are spread across the globe. Each location is at a different phase in their fight to contain the virus and each plant is subject to local government regulations on work practices. The good news is that, so far, almost all our facilities continue to operate and our supply chain is working. On the demand side, our book to bill remained just above one in the second quarter, but bookings may slow as we move through the rest of the year and our customers adjust their orders in line with the end market demand. What that demand will look like is difficult to determine.


Summary Guidance

We all find ourselves in unprecedented times. Today, as we face the immediate COVID-19 lockdown and the ensuing economic fallout, we believe we are relatively well positioned. Our diversity across markets and our strong balance sheet are key to navigating the short-term challenges, while the strength of our franchise and our fundamental approach to business are the basis for our continued long-term success.  

Over the years, we’ve described the fundamentals of our business as follows.  

1) We solve our customer’s most difficult technical challenges.

2) We develop a leading position in niche technologies across a diverse range of markets.

3) We develop unique IP both in product design and manufacturing.

4) We believe in a conservative financial approach to business.

Our highly technical products, specifically designed to meet our customer’s applications, make it very difficult to be replaced by alternative sources of supply.  Therefore, our fortunes will rise again as our customers recover. Our investment in R&D and our staff of highly skilled engineering talent will continue to create new opportunities to provide value to our customers. Our prudent approach to capital allocation and focus on maintaining a strong balance sheet will allow us to rebuild for the longer term.  

Finally, we believe our employees are our most important asset. Our culture of trust, integrity and cooperation means that our leadership and staff around the world are committed to the long-term success of the company.  

As we look out over the coming 6 months, we believe our defense, space and medical businesses will remain strong. Our industrial business is likely to face some challenges and our commercial aircraft business will be hardest hit. As the picture becomes clearer we will take all necessary steps to restructure our business to this new reality. Beyond that horizon, it is difficult to say, but our diversity across end markets should serve us well as some markets recover ahead of others.  Throughout this time, we will continue to invest in R&D, process improvements and long-term initiatives that will provide benefits for years to come.

Let me finish with this thought. I believe in years to come, we will tell future generations about the time the world stood still. And then, one day, it started turning again.  

Now let me pass you to Jennifer who will provide more color on our cash flow, balance sheet and COVID-19 financial modeling.

Thank you, John. Good morning, everyone.

We come into the current situation from a position of relative financial strength.  Earlier in our fiscal year, we refinanced the debt on our balance sheet which provides us with liquidity and financial flexibility. As business challenges emerge related to the pandemic, we’ll maintain our financial health from two key factors.  First, as John described, we will benefit from the diversity in the markets we serve.  Second, we’re taking action to assess and address the financial implications in the current environment. I’ll cover these topics in more detail, but first I’ll walk through our cash flow for the second quarter and other topics we typically describe.

Free cash flow in the second quarter was $12 million, and was $27 million for the first half of the year; that’s a conversion ratio of 27%. We had expected this slow start for free cash flow generation in the first half of 2020.

The $12 million of free cash flow for Q2 compares with an increase in our net debt of $124 million. The difference includes share repurchases. During the second quarter, we repurchased 1.6 million shares at an average price of $75 for a total of $120 million. We also paid $8 million for the quarterly dividend and $4 million for the early redemption of our $300 million senior notes.

Net working capital (excluding cash and debt) as a percentage of sales at the end of Q2 was 29.6% compared with 28.8% a quarter ago. The increase largely reflects growth in physical inventories. We are continuing our Operations 2.0 activities in our Aircraft Group, but these activities slowed late in our second quarter and will be moving forward at a rate lower than previously planned. These activities will  reduce net working capital levels over time.

Capital expenditures in the second quarter were $26 million, while depreciation and amortization totaled $22 million. Both capital expenditures and depreciation and amortization continued at levels from our first quarter.

Our leverage ratio, which is net debt divided by EBITDA, increased to 2.6x from 2.3x a quarter ago. The increase in our leverage ratio was driven by our share buyback activity in the quarter. Net debt as a percentage of total capitalization was 44%, up from 39% last quarter.

Our effective tax rate was 19.2% in the second quarter compared to 23.8% in the same period a year ago. The lower rate in this year’s second quarter primarily reflects the reduction in tax rate related to taxes accrued on accumulated earnings in one of our foreign jurisdictions. In addition, legal entity restructuring resulted in reduced withholding taxes previously accrued in another foreign jurisdiction.

Cash contributions to our global retirement plans totaled $12 million in the quarter, compared to $10 million in the second quarter of 2019. Global retirement plan expense in the second quarter was $20 million, up from $18 million in the second quarter of 2019. Our largest defined benefit plan is in the U.S. and has been closed to new entrants for more than a decade. We fully funded this plan in 2018, at which time we shifted our investment strategy to derisk our portfolio. We’re invested 80% in liability hedging assets and 20% in return seeking assets. As a result, our portfolio is largely insulated from the recent market turbulence, and we continue to be fully funded. The funded status has also remained stable for our international pension plans.

The impacts on our business from the COVID-19 crisis started to become evident late in our second quarter. John referenced that our strong second quarter results provide a solid foundation as we enter this crisis. The same is true from a balance sheet perspective. We entered this situation having recently refinanced the debt within our capital structure.  

This past October, we amended our $1.1 billion U.S. revolving credit facility, obtaining more favorable terms, both with respect to interest rate and financial flexibility. We also extended the maturity, such that it now runs through October 2024.

In addition, we issued $500 million of 4.25% senior notes that mature in December 2027, and we redeemed and retired $300 million of 5.25% senior notes that were set to mature in December 2022.

We also extended our securitization program through October 2021. This program effectively increases our borrowing capacity and lowers our interest rate on up to $130 million of borrowings.

These refinancing activities position us nicely coming into the situation we now face.

Our net debt was $975 million at quarter end. We had $119 million of cash and $1.1 billion of debt. The major components of our debt were $500 million of senior notes, $473 million of borrowings on our U.S. revolving credit facilities and $130 million outstanding on our securitization facility.

We have available borrowing capacity on our U.S. revolving credit facility. At the end of our second quarter, the unused balance on this facility was $600 million.  Our ability to draw on the unused balance is limited by our leverage covenant, which is a maximum of 4.0x on a net debt basis. Based on our leverage, we could have incurred an additional $536 million of debt as of the end of our second quarter.

We have assessed the financial impacts on our business from the pandemic and will continue to do so as the situation evolves. We are estimating the pressures on our sales, profits and cash flow, all the while considering the risks and uncertainties involved that widen the range of potential outcomes.

Our businesses are facing varying levels of pressure depending on the markets they serve. Looking to the second half of the year, our defense and space businesses may face only modest pressures associated with supply chain risks and productivity levels. Our medical business is strong and likely unaffected. These businesses represent over half of our sales. Our industrial businesses may see supply chain, productivity and demand challenges, so we’re assuming sales to be pressured by up to 25% in the remainder of the year. Finally, commercial aircraft faces the greatest pressures with demand declining associated with steep reductions in flights. In the short term, the aftermarket is likely to be impacted more than OEM, and we’re modeling second half sales declines for all of commercial aircraft between a third and a half. Due to the uncertainties with respect to severity and duration of this situation, we are not providing specific financial guidance as we have in the past. However, we can share some insights. The scenario I described suggests that sales could decline from the first half of the year to the second half by 10 to 20%. Right sizing our business will take a little time, so it’s possible that we could experience a marginal loss on sales in the 30 to 40% range over the second half of this fiscal year.  

We have been proactive in implementing measures to counteract these impacts.  Our immediate financial focus revolves around cash preservation and cost management.  

We are making significant adjustments to our major capital deployment activities in the current environment. We have paused our M&A pursuits for the time being.  We had been active in our share repurchase activity, but suspended purchases in mid-March when financial uncertainties became evident. We are also temporarily suspending our dividend program. In addition, we are delaying most capital expenditures that are not business-critical or compliance-related. Each of these actions helps to preserve our liquidity. We’re also preserving our liquidity in other ways such as reducing incoming inventories from our supply chain to be in line with expected demand, taking advantage of payment deferrals and implementing financing programs.  

We are implementing measures to mitigate the earnings impact of this situation, in addition to providing cash relief. These measures include workforce and expense management and are important as they not only preserve our cash, but also protect our earnings. This in turn protects our leverage, allowing us to more fully access the credit on our revolving credit facility.  

We believe that our existing financial arrangements, along with the actions we’re taking to mitigate the business pressures we’re facing, will be sufficient to weather this storm over the coming quarters. In addition, we have long-standing, strong relationships with our bank group and access to capital markets that can provide further funding sources should the situation become more stressed.

In the current environment, we have shifted our capital deployment strategies from a long-term perspective that balances growth and capital returns with one that focuses on liquidity and leverage in the near term. We are committed to ensuring that we have adequate liquidity during this crisis, protecting the long-term health of the company and emerging financially strong and ready to capitalize on opportunities once this situation passes.

With that, we’ll turn it back to John for any questions you may have.